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Title:Moral hazard and the composition of transfers: theory with an application to foreign aid PDF Logo
Authors:Amegashie, J. Atsu
Ouattara, Bazoumana
Strobl, Eric
Issue Date:2007
Series/Report no.:CESifo working paper 1996
Abstract:The paper presents a theoretical and empirical analysis of a donor’s choice of the composition of unrestricted and in-kind/restricted transfers to a recipient and how this composition is adjusted in response to changes in the moral hazard behavior of the recipient. In-kind or restricted transfers may be used, among others, to control a recipient’s moral hazard behavior but may be associated with deadweight losses. Within the context of foreign aid, we use a canonical political agency model to construct a simple signaling game between a possibly corrupt politician in a recipient country and a donor to illustrate the donor’s optimal choice of tied (restricted) and untied foreign aid. We clarify the condition under which a reduction in the recipient’s moral hazard behavior (i.e., improvement in the level of governance) leads to a fall in the proportion of tied aid. We test the predictions of our theoretical analysis using data on the composition of foreign aid by multilateral and bilateral donors.
JEL:D73
F35
H87
I38
Document Type:Working Paper
Appears in Collections:CESifo Working Papers, CESifo Group Munich

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